By Dr. Uma Shashikant
This article walks us through the opportunities and risks
of investing in India. People are all
ears to the India story, the author takes us through the risks and
opportunities. Dr Uma Shashikant is a founder and chairperson of CIEL and holds
a doctorate in finance. She is well known as a writer, speaker, researcher,
consultant and trainer.
India as an investment opportunity is a theme that has
persisted for a long time, since we opened up to global capital inflows in
1993. The novelty about India as an emerging market was very high in the
initial period, and then the story was tempered by several ups and downs in the
last 25 years. There was a time when the primary attraction of India was its
insulation from global markets, evidenced by a low correlation with most
markets. During periods of crisis and collapse elsewhere, Indian stock markets
seemed unscathed. All that changed soon. By 2007 it was clear that India was
not decoupled from the world, but quite amenable to being impacted by global
head winds. Investing in India still remains an attractive proposition, both
for global and local investors due to the sheer opportunity for growth.
The attractiveness of emerging markets like India, and the
returns such markets offer to investors arising from the potential that a
growing economy offers. Benefits of market expansion, development of new
technologies and innovations, growth in infrastructure, services and
manufacturing sectors, higher rate of GDP growth compared to the rest of the
world, stability from elected governments, free press and democratic
traditions, and modernisation arising from increased exposure to the world, are
all enduring factors that make India an attractive investment story. Domestic
investors who in the thick of all the action taking place, are better poised to
make the most of these opportunities. Several institutional investors, domestic
and global, view India as a very profitable long term investment play and
returns on investments corroborate that assessment.
Quality concerns
Where do the risks lie? The primary risk to an investor in
India is the quality of businesses they choose. Private equity investors are
quite used to an intense search for investment opportunities, but they would
also testify to the difficulties in finding good businesses to invest in India.
There is an underlying culture of exploitative capitalism in play, made worse
by favouritism, corruption and lack of enforcement of the rule of law, that
make Indian markets very risky to the investor. There are innumerable examples
of business success that came about not because of innovative entrepreneurship,
but mere crony capitalism at play. It takes a while to understand how nefarious
players could spoil otherwise thriving and growing opportunities in coal,
power, mining, roadways, banking, real estate, jewellery, and airways to name a
well-known few, to short cut the process for private profits. Many businesses
have emerged to be a kind of mafia in their own right, encumbering upon public
goods for private gains, making many investors wary.
There are world class businesses that India has built; there
are innovations that the country and its entrepreneurs can be proud of; there
are foreign collaborations that have worked excellently to bring quality
products to India and benefit from the growing markets here. However, to the
discerning investor, the problem of not knowing whether a business succeeds
from strong strategy or the existence of crony capitalism hiding from plain
sight is a tough one. Selecting the right businesses to back remains a
challenge for the investor in Indian markets.
The second big challenge to investors is the burden of
historical baggage. Nowhere is this evident more starkly than in the banking
sector in India. The policy misstep of nationalising banks many years ago and
stripping the banker of accountability in lending decisions has created
tremendous damage to the banking sector. Despite the opening up of the sector
to competition and the implementation of various recommendations to strengthen
the system, the problem of poor quality assets has only grown with time, and is
now large enough to threaten the existence of erstwhile strong banks. From a
time when we believed that the public sector would lead the economy and build
institutions of benevolence in a socialistic model, we have taken a turn to
embrace capitalism and the market economy. However, we still have several
businesses owned by the government in a range of sectors from airlines, mining,
transportation, metals, beverages, hotels, telecom, and insurance. While
accepting that the government has no business to be in business, we have
neither privatised these, nor dismantled the bureaucracy that supervises them.
To the investor, the existence of these pockets of
inefficiency that simultaneously enjoy government patronage, is a risk. How
would one evaluate the banking sector, for instance? Would one see it as a
growth business that can exploit the low penetration of banking services, the
huge potential to expand credit, and the opportunity to formalise several
informal sectors? Or would one see it as a risky business with a systemic risk
of a possible bank failure from NPAs? Or is it a sector with the lack of clear
policy guideline with respect to the treatment of a bad asset, its recovery and
rework of the balance sheet? To an investor the presence of historical baggage
is an unresolved risk that makes an investment decision needlessly complicated.
There are always fears of the immediate events and factors
that may matter in the foreseeable future. That 2019 is an election year is a
factor that weighs on the minds of several investors. They would worry about
policy decisions that pander to the electorate and interest groups of the
ruling party, and about reckless decisions with an eye on the ballot. Or they
would worry about possible destabilisation from a result that may not bring a
majority government. One of the primary reasons for our inability to forge
ahead the path of reforms we set upon in 1991 has been the various ragtag
coalitions that have ruled the country and investors continue to be wary of
that risk. However, the resilience of Indian businesses to the political risks
and changes in the parties that ruled has also been established in the last 25
plus years. Therefore the long term investment story for India is more about
the opportunities offered to businesses by the unique factors that enable growth, than about the risks from the political
environment.
Enough has been written about the demographic advantages of
India, the high GDP number, the opportunity for the economy to double in record
time, and the growth from growing global exposure. Let’s consider two
overarching themes that will matter to the long term investor, who would like
to stay invested and make the most out of the opportunities offered by an
emerging economy like India.
The first theme is the consumption story that will primarily
drive India’s growth and offer the highest potential for investment returns.
The second theme is the one that will temper these returns and remain outside
the realm of control of the investor – the changing global trends. An
investment strategy that considers both these factors is likely to benefit the
investor the most, in terms of balancing risks and return.
Consumption
The Indian consumption story has been told with various
modifications and nuances ever since the economy opened up in 1991 and the
theory that consumers will propel growth gained ground. The liberalised Indian
market place of the last 27 years has been undoubtedly driven by consumers.
Most sectors that saw significant growth and gains in those years, from telecom
to automobile and tourism to fashion have benefitted from the ability and
willingness of the Indian middle class to spend more. Boston Consulting Group estimates
that India’s household spending will triple to $4 trillion by 2025. The middle
class is estimated at 600 million, a number that is about twice the population
of the US, about 60 million short. It is tough to ignore the impact of the
wallet of the middle class Indian.
The consuming Indian had not been easy to stereotype. Many
global brands have watched in dismay when fake versions of their produce flood
the market with cheap lookalikes. They reported that the Indian consumer was
willing to compromise quality for price. Even before they began to generalise
that Indians may be unwilling to pay top dollars, the expansion of the markets
for luxury goods left most observers stumped. From luxury homes to cars,
jewellery to destination weddings, Indians seemed quite willing to splurge.
Early observers looked at urbanisation as the trigger for consumption. Soon
enough, the demand for goods and services from rural markets began to outpace
urban markets, and many producers modified their strategy to capture the imagination
of Bharat, rather than India alone. Before we theorise that the new demand will
be driven by the millennials, there are studies that show the emerging spending
power of the newly retiring Indian who is ready to buy more toys, travel the
world and pay for a new experience. Tracking the trends in the Indian
consumption story has thus remained a challenge. The risk in this sector also
stems from these changing assumptions about consumer spending.
We can divide consumption into two categories – essential and
discretionary. The rate of growth in discretionary spending is estimated to be
much higher than the rate of growth in essential spending. There are two
primary reasons: First, the rate of inflation that applies to essentials has
been lower, while prices of discretionary items have been increasing more
rapidly. Second, the availability of bank loans and the increased use of formal
credit by households has enabled a higher discretionary spend. The amount a
household spends on transport and travel is no longer dictated by cost of
public transport, when it is easier to obtain a bank loan and get to work in a
personal vehicle.
The investment opportunities triggered by the consumption
story are quite vast, wide spread and subject to a steady and sustainable
growth over a long period of time. A long term investment strategy will ride
the consumption story and the growth prospects it holds. Food and beverages,
alcohol and entertainment, clothing, fashion and accessories, automobiles,
telecom, housing and communications are all sectors that directly benefit from
the Indian consumption story.
Investors in the consumption driven sectors have a diverse
range of opportunities: Several PE firms and boutique investment firms
routinely chase consumption stories for their growth opportunity. Portfolio
managers offer thematic plays that focus on consumption to provide a
concentrated bet; mutual funds offer both diversified portfolios and thematic
funds to capture this opportunity; and the simple low cost index funds offer a
diversified bet that also has significant weightage to consumption stories.
Growth investing in India would not ignore consumption driven sectors.
Global Trends
The changing world order is always a challenge to investors.
Much as one would like to invest within the local context and primarily in
domestic businesses, the performance of those businesses as well as the stock
markets where these businesses are valued, are significantly impacted by global
trends and policies of various governments. Returns and risk of various asset
classes is impacted by these global trends. The emerging risks to oil from the
growing tension in the Middle East, and the broad projection that we are headed
towards $100 per barrel for crude, alters so much for the Indian markets. As a
net importer of crude, and as a country with high dependence on oil and a lower
level of export engagement with the world, rising oil prices will impact our
balance of payments, lead to a depreciation in our currency, and also impact
our fiscal balances.
There is then the question of FII flows, which are impacted
by both strategic and tactical allocations based on the global trends. If there
is a negative global outlook arising from rising oil prices, tense global trade
and policy relations, and uncertainty about the direction the developed world
would take, overall strategic allocations to emerging markets would fall, as
money remains risk averse and in home markets of global investors. In that
context, the tactical allocations between various emerging markets and the
relative share of India in global capital flows would not matter much. It is an
overall positive scenario for global flows that the relative attractiveness of
India in terms of its GDP growth, market performance, domestic consumption and
investment, and quality of government and policy will matter more.
The risk of a no holds barred trade war will have its own
ramifications for the global economy, and most leaders are keen to avoid an
escalation of the retaliatory stance on tariffs and protection. Years of work
done by the WTO to dismantle destructive tariffs are now under the risk of
being undone, and the carving out of nations by their protective measures will
impact many economies. Given India’s limited engagement with the world, this
may not seem like a big impact on our economy, as compared to other
export-dependent regimes. However, global trade wars combined with restrictions
on immigrants in Western economies can seriously impact technology and services businesses.
The interest rate cycle is another matter of concern. While
India has begun to increase its rates, it does seem to have done so
reluctantly, and the expectation that US would not increase rates too much too
soon underlies the monetary policy assumptions of many economies including
India. However, it has become quite complicated to venture into the business of
projecting how the developed economies, especially the United States would
perform in the next few years. While there is optimism about resilience and revival
of the economy and the possibility of a sustained 4% GDP, there is worry about
the trade and tariff policies unraveling to the detriment of the US. Many
Western nations as well as exporters like Japan and China, and many nations in
Asia and the Middle East are known to be grouping up to work together in the
light of what is seen widely as disruptive trade policies of the US. Greater
the unknowns, greater the risks to the investor.
Plan of action
How does an investor develop a strategic outlook for investing
in the Indian markets given these opportunities and risks?
First, every market offers the opportunity for beta returns
that come from investing in the broad market and the alpha returns that come
from outperformance. Investors should target a combination of the two. It is
quite common for investors to focus too much on alpha. Many would think that
investing in equity is not worthwhile if extraordinary returns are not earned.
It is important to see that stable long term story that India represents is
best captured by the index or a diversified portfolio of stocks that broadly
invests across sectors. Such a portfolio may not include the spectacular stars,
but it holds the merit of being a default choice to invest, an easy decision to
make during all times, a theme that is worth investing in for the long term,
and being diversified a low-risk choice for most investors. A diversified
portfolio that offers market returns should be the base, over which all else
can be built.
Second, the dilemma of
large cap versus mid cap is a tough one to resolve in the Indian markets. While
large cap stocks offer stability, the returns from the mid cap opportunity is
too high to ignore. In an emerging market like India, it is the business that
begins small, shows agility to grow rapidly, and become a blue chip in a short
span of time, that holds investor interest. There are several examples of
business that became big thus. However, the risks of failure are high in the
mid and small cap space as not all businesses succeed in what they set out to
do. An investment strategy that has a core and a satellite component, with
large cap as core and mid and small caps as satellite would help balancing the
portfolio. The relative weights can be modified to overweight large caps during
times of uncertainty and overweight mid and small caps during times of optimism.
Third, investors love the
idea of being value driven and like to see themselves as chasing good
investment opportunities at a reasonable price. However, a market like India
offers more opportunities for growth and momentum, than value. A beaten down
business may not represent a cheap buy, but an incorrigible loss. Most money in
Indian markets has been made from growth and momentum than from value. Momentum
is risky but holds the lure of a quick gain, making short term day traders out
of once innocent bystanders. It is astonishing how many try to make money
staring at blinking screens and staking too much money on what they see as
going up. Investors have to make their choices – to invest is to choose
carefully and focus on the return; to trade is to have an algorithm or action
plan and focus on the capital. The two are completely different tactics and
need different kinds of skills and attitudes.
There is money to be made in the long term on a diversified
portfolio across sectors, built carefully, monitored regularly, and pruned
sensibly. It just boils down to implementation, which most investors admit is
tougher than assumed.
